Simple repayment back in fashion
Sunday 29 September 1996
Endowment policies have lost much of their popularity and this has heralded the return of the traditional repayment mortgage.
But more esoteric options are available, such as mortgages backed by pensions or personal equity plans (PEPs). For the sophisticated it is even possible to arrange an interest-only mortgage, relying on profits when the property is sold, windfalls and inflation to pay off the debt. The best mortgage scheme will depend on your circumstances and intentions. Key issues will include the likelihood of your moving again in the next few years, the stability of your income, attitude to risk and confidence in investment prospects.
Repayment mortgages are the simplest. The mortgage payments reduce the amount of the loan month by month, though in the early years borrowers are mostly paying interest to the lender rather than repaying capital. Consequently, if you move home after only three or four years, you will have made little impact on the size of the loan. This, and the fact that most borrowers take out another 25-year loan when they move, have been seen as drawbacks.
However, Patrick Bunton, the marketing manager at London & Country Mortgages, a firm of mortgage brokers in Bath, regards these objections as rubbish. He says when interest rates are low, as now, borrowers are able to pay back capital quite quickly. Mr Bunton says that if you do decide to move after a few years there is no need to take out another 25-year mortgage as it is perfectly possible to arrange the loan over (say) 22 years.
Repayment mortgages mean higher monthly payments than endowment mortgages. If interest rates were to climb back above about 7.5 per cent endowments would cost more.
With mortgages other than repayment loans borrowers pay interest on the full amount of the loan for the entire term. Most borrowers will also put money into a separate savings scheme (an endowment policy, a PEP or a pension plan) whose proceeds will be used to pay off the loan.
Although sales of endowments have fallen sharply they are still used by 45 per cent of all new borrowers, according to figures from the Council of Mortgage Lenders. In the past borrowers who maintained payments through to maturity often did well, generating a handy surplus on top of the amount needed to pay off their loan.
Unfortunately, many borrowers have surrendered their policies early, when they lost their jobs, divorced, or switched mortgage. The surrender values paid out often represented an atrocious return. Another problem has been the cuts in the bonus payments made on "with-profits" life policies, made necessary by falling returns.
PEP mortgages are backed by a tax-free savings plan that invests in shares or share-based investments, such as unit trusts. Although much praised in the financial press they are used by only one in 50 new borrowers.
Their main drawback is that, unlike with-profits endowments, they are exposed to the ups and downs of the stock market.This makes them suitable only for borrowers who are comfortable with fluctuations in the value of their savings.
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